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Voices: The death of brokerage fees was 50 years in the making

It looks as if 2019 will be remembered as the year when stock brokerage fees, having declined for years, finally disappeared altogether. Led by the free stock-trading startup Robinhood, a host of big names have eliminated fees: E*Trade Financial, Charles Schwab, TD Ameritrade and many others.

Although it’s tempting to credit this development to online platforms, this is a revolution 50 years in the making. In the late 1960s, some iconoclastic reformers started a campaign to kill off fixed brokerage fees. Today, we’re witnessing the logical culmination of that effort.

It’s hard to imagine now, but for most of Wall Street’s history, the New York Stock Exchange required member brokers to charge customers a minimum commission rate, typically a percentage of the par value of the shares traded. This was a function of the NYSE’s identity as a quasi-cartel that ensured all member brokers a share of the commission pie, shielding them from the ruinous effects of no-holds-barred competition.

That one of the primary engines of American capitalism once engaged in deeply anti-competitive behavior may seem strange, but for the architects of the NYSE, this was a sacred creed. In 1894, the NYSE’s Governing Committee called the minimum commission rule “the fundamental principle of the Exchange … on its strict adherence hangs the financial welfare and the life of the Institution itself.”

This sentiment prevailed well into the 20th century, surviving the creation of the SEC in the 1930s. In fact, New Deal reformers didn’t want to touch minimum commissions, fearing that their removal would spark dangerous speculation in the stock market.

By the 1960s, though, the brokerage fee structure had come under strain. The key was the rise of institutional investors. Big players like insurance companies and pension funds accounted for only a fifth of total trading volume in 1950; a decade later they accounted for a solid majority.

Stock brokers welcomed them. After all, they got a far larger commission with the buying and selling of large blocks of shares, even though it wasn’t really any more work. But these large commissions had the inadvertent effect of undermining the minimum-fee structure: Brokers were so desperate to land big customers that they began bending the rules.

How they did so was a testament to the brokers’ ingenuity. The NYSE brokers couldn’t abandon the fixed-rate structure, so they negotiated what was known as a “customer-directed give up.” A big institutional investor would buy (or sell) a large block of shares and pay the broker the standard fee. But the customer would then direct the broker to “give up” upward of 70% of the fee, redirecting it to other brokers who had done other work for the client: equity research, for example.

This was price competition camouflaged via an elaborate network of rebates and redistributions — and it worked, if imperfectly. As the Wall Street Journal observed, “There was so much fat in the commission on large orders that brokers were willing to negotiate the size of their fee with the large customers, then give away the rest.” Of course, the same privilege wasn’t extended to individual investors; they had to pay full freight.

The Justice Department’s Antitrust Division knew what was happening, and as early as 1967, it urged the NYSE to abandon its attachment to fixed commissions. The NYSE fought back. Robert Haack, its newly appointed president, warned Congress that negotiated rates might lead to the “undoing of the world’s principal securities market.” But the government would not be moved, with the SEC likewise recommending reform.

What changed things, though, was the conversion of none other than Haack himself. In what the New York Times would describe as “perhaps the most controversial speech ever given by a Big Board president,” Haack in late 1970 got up in front of a dinner attended by the governors of the NYSE and other Wall Street players. The attendees expected a conventional boring speech. Instead, as historians Janice Traflet and Michael Coyne have chronicled, the listeners received a tongue-lashing.

Haack blasted the fixed-rate rule, blaming it for what he described as “indiscreet excesses” and “inept management” at brokerage firms battening on excessive fees. He counseled the NYSE to abandon “archaic and anachronistic practices and procedures,” and bluntly told his listeners that the “vestiges of a private-club atmosphere which remain at the New York Stock Exchange must be discarded.”

This speech aroused intense indignation, with many calling for his removal. But Haack didn’t back down: The fixed-commission system was driving a growing number of investors into third-party contracts outside the purview of the NYSE. If this continued, the Big Board might become irrelevant.

Haack wasn’t alone. Merrill Lynch and Salomon Brothers issued calls for reform, recognizing that they could readily compete — and profit — in a world of competitive bidding. Others, like newly created discount broker Charles Schwab, also pushed for deregulation, seeing an opportunity to grab business from firms ill-prepared to fend for themselves.

The SEC forced reform on the NYSE in several steps. The first was an order that brokers making transactions of half a million dollars or more had to submit to negotiated rates, but only on the amount above that critical threshold. This led to additional changes. In 1973, the SEC demanded that the NYSE abolish fixed rates by May 1, 1975; Congress followed suit, writing this date into an amendment of the Securities Act.

Robert Baldwin, the head of Morgan Stanley, dubbed the deadline “Mayday,” after the common code for distress. But May 1 came and went, and the world did not end. A year later, 11 underperforming brokerage houses had merged with competitors; nine more failed altogether. But this was a far cry from Baldwin’s prediction that up to 200 investment banks would go under.

The benefits of competitive pricing, though, overwhelmingly went to the biggest institutional investors, with brokerage fees declining as much as 50%. Wealthy investors also managed to secure cut-rate commissions. Small investors initially saw their rates go up, largely because the big brokerage houses had no interest in dickering over fees for a tiny trade.

But as fees rose for ordinary investors, this opened the door to yet another revolution: the proliferation of bare-bones discount brokers operating along the lines of Schwab. A decade after Mayday, the Wall Street Journal counted more than 600 discount operations luring away investors from conventional stock brokerages. This in turn helped fuel a democratization in stock market participation. As trading costs fell, more investors dabbled in the market, fueling yet more competition for their business.

The advent of computerized trading platforms drove the decline in fees as well, but in reality, the key steps had been taken many years earlier, when the NYSE finally unleashed capitalist forces on their own brokers. Indeed, one researcher who has researched commission costs has tracked a long steady decline that dates back to 1975.

And now we’re finally at zero: Trading is free. The revolution started by government regulators and Robert Haack has reached its inescapable conclusion.

Bloomberg News